MSc Management with Streams

“Financial Decision Making”

[FIN 7040]
“Executive Summary”
The purpose of this report is to evaluate the attractiveness of “Roast Ltd.” as a “target for
acquisition” by the “Starbucks Coffee Company”. This report has been presented to the chief
financial officer of “Starbucks Coffee Company” in order to successfully convince them that
“Roast Ltd.” is a viable option for a successful acquisition. This report consists of an overview of
the coffee industry of the “UK” outlining the current trends in the coffee industry and the market
share of the key players of this industry. The review also demonstrates the overall performance
of the coffee industry in light of the existing political and economic factors. The following report
also contains a detailed analysis and comments on the “financial performance” of “Roast Ltd.”
beginning with any valuation of its “profit or loss statement” of the financial year 2017 and
2018. The business performance analysis also consists of a “statement of financial position”
which has been assessed from the given data of “Roast Ltd.” the statement of cash flow has been
calculated unexplained using the operating cash cycle of “Roast Ltd.” for the financial year
“2018” and “2017”. Based on that, the “company's dividend policy” for 2018 has been critically
evaluated. Investment appraisal has also been developed in this report based on the given data of
“Roast Ltd.”. In this “investment appraisal” the “management forecast” has been challenged with
the use of existing investment appraisal techniques as well as taking into consideration the
limitations and benefits of each technique. Furthermore, “investment appraisal techniques” like
the “payback period”, the “accounting rate of return”, and the “net present value” have been
stated as well. Given the fact that “Roast Ltd.” is pondering upon further investments across the
UK into the European Union, specifically Italy, the limitations and benefits of two alternative
sources of finance for this have been assessed. In conclusion, recommendations for suggested
courses of action regarding the same have been stated in this report.
Table of Contents
“Executive Summary”.....................................................................................................................2
“Part 1: Industry Review”................................................................................................................4
“Part 2: Business Performance Analysis”........................................................................................6
“2.1 Statement of Profit or Loss”.................................................................................................6
“2.2 Statement of Financial Position”..........................................................................................6
“2.3 Statement of Cash Flow”......................................................................................................7
“Operating Cash Cycle of Roast Ltd.”.....................................................................................7
“Dividend Policy”....................................................................................................................8
“Part 3: Investment Appraisal and Sources of Finance”.................................................................9
“3.1 Investment Appraisal”..........................................................................................................9
 “Management Forecast”....................................................................................................9
“Investment Appraisal Techniques”..........................................................................................10
 “Payback Period”............................................................................................................10
 “Accounting Rate of Return”..........................................................................................10
 “Net Present Value”........................................................................................................10
“3.2 Sources of Finance”...........................................................................................................11
“References”..................................................................................................................................12
“Part 1: Industry Review”
The “coffee industry” and “coffee house industry” of the “UK” generally consists of specialist
unlicensed establishments or stand-alone coffee houses that focus on the sale and service of hot
and cold beverages including snacks and light meals. Performance evaluation of this industry
usually consists of a few metrics like economic and social factors, growth of disposable
household income, preference of cafes over alternative social venues as well as the level of
customer interest in different types of coffee blends and their origins. Just as the coffee culture is
becoming more and more prevalent among the youth and the business class of the UK, this
industry has also grown significantly from the year 2014 to 2019 [ CITATION Ceb18 \l 1033 ].
As observed the compound annual “growth rate of the coffee industry” in the “UK” has been 4.8
% while the growth in the current year 2018 to 2019 has been 1.9 %. However the total
aggregated growth from the year 2014 to 2019 in the coffee industry of the UK has been 6.1 %.
The largest Market share holders and “players in the coffee industry” of the “UK” are “Costa
Coffee”, “Pret A Manger”, “Starbucks Coffee Company”, “Caffe Nero Group Holdings”, and
“AMT Coffee Ltd.” [ CITATION IBI19 \l 1033 ].

In order to understand the recent trends in the coffee market of UK it is necessary to look at the
largest brands operating in the market. For example, “Costa Coffee” mentioned above has 2,121
outlets in the UK, “Starbucks Coffee Company” has 898, “Caffe Nero” with 650 outlets and
other smaller change like “Cafe2U”, “Coffee #1” etc., having 30 to 70 outlets all over the UK
[ CITATION Sta16 \l 1033 ]. According to senior food service analyst Trish Caddy it has been
observed that food service outlets that have a significantly wide range of food of runs along with
decent range of hot and cold beverages including coffee have proficiency e over specialist coffee
outlets and chains. The coffee consumer market has largely been transformed into a budget
market where the business persons and the youth are beginning to prefer budget coffee as
opposed to specialised Barista style coffee [ CITATION Min19 \l 1033 ].

Looking at the trends in the coffee industry of the UK in much more detail, it can be observed
that there are six most identifiable trends here –
 The High Street - According to popular research location is the “most significant factor”
that contributes to the success or failure of a coffee shop on the High Street of UK.
Consumer data also suggest the same. Some popular locations for brick and mortar coffee
shops in the UK are near train stations, busy shopping centres, and residential areas. It is
evident from the location of the different outlets of roast Ltd that their locations offer an
attractive prospect for a thriving coffee business [ CITATION Esq19 \l 1033 ].
 Innovation - Innovation in the “coffee industry” of the “UK” has been a driving factor
towards increase consumer demands for better quality of coffee. Recent trends suggest
that consumers now demand coffee that it is of a higher quality as well as having
ingredients that are ethically sourced and packaging material like cups and saucers that
are environmental friendly. Among these trends fair trade coffee has become a popular
demand among consumers who are conscious about giving back to the community
[ CITATION Esq19 \l 1033 ].
 Political and Economic - In regards to the political scenario in the UK, the issue of
Brexit has caused significant uncertainty in the economic relationship of the UK to the
European Union and this has also affected the coffee industry of the UK. Following the
Brexit vote despite the anxious speculations of industry leaders of the coffee industry
coffee shops have continued to thrive in the UK. Moreover a specific Barista visa has
also been debated by the UK Government in order to allow work rights in the UK for
citizens of the European Union [ CITATION Esq19 \l 1033 ].
 Mergers and Acquisitions - Mergers and acquisitions have been an important part of
any business and the same is true for the coffee industry in the UK. Several venture
capitalists have invested in existing coffee business chains. The large coffee brands
mentioned area a continually looking to expand their outreach by acquiring smaller
localised coffee change in the UK and in this aspect, “Roast Ltd.” can prove to be “an
attractive investment for Starbucks” [ CITATION Esq19 \l 1033 ].
 The 5th Wave - One of the most significant trends that can be identified in the “coffee
industry” of the “UK” is the development of the 5 th wave as a form of a new measured
and boutique hospitality. This 5th wave development brings coffee consumers revamped
experience that consists of a revolutionary and speciality environment in coffee service.
The main catalyst for this 5th wave development is the continuous growth of consumer
 demands seeking unique experiences in terms of cafes and coffee shops. As a result
franchising and acquisition has become a popular way of expanding coffee businesses in
the UK where customers are always seeking innovation in their coffee experiences
[ CITATION Esq19 \l 1033 ].

“Part 2: Business Performance Analysis”

“2.1 Statement of Profit or Loss”

Essentially a financial statement is the “statement of the financial accounts” of a company in
terms of operational costs, the revenue generated as well as other overhead expenses the
company incurs. In the context of “Roast Ltd.” this statement of profit or loss is for the fiscal
year of 2018 and 2017. In the given “statement of profit or loss” for “Roast Ltd.” the cost of
sales for the financial year of 2017 can be observed to be £1,505,000 while that of the financial
year of 2018 has been recorded to be £1,990,000, which is typically in the loss area. In spite of
that, a gross profit of £517,000 can be seen in the financial year 2017 and of £544,000 can be
seen in 2018. On the basis of this financial statement the operating expenses financial costs and
income tax expenses of “Roast Ltd.” it seems to be in the loss area. However the profit for the
period of 2017 has been calculated to be £36,000 and that of 2018 has been calculated to be
£81,000 in total. In order to increase the net profits of “Roast Ltd.”, it is suggested that the bad
that charges, legal and professional fees as well as a marketing and advertisement costs need to
be curtailed [ CITATION Chr201 \l 1033 ]. Operational cost reduction techniques can be applied
to control the several excesses in operating costs that have significantly contributed to the
reduced net profits of “Roast Ltd.” [CITATION Mor202 \l 1033 ].

“2.2 Statement of Financial Position”

The “financial position of a company” like “Roast Ltd.” can be calculated in terms of the
financial statement of profit or loss, the cash flow statement, the balance sheet of assets and
liabilities and the recorded values, and equity of the owner. An asset report is developed by
companies which state the “financial position of the company” in regards to both the current as
well as non-current assets [CITATION Ser18 \l 1033 ]. This type of “financial position report”
states the current position of the company clearly and can be useful in charting future plans so
that the current assets can be developed into revenue sources for the company and the non-
current assets can be used for the operational development of the organisation in the future
[ CITATION Kje19 \l 1033 ].

 For “Roast Ltd.” the value of “non-current assets” for the financial year “2017” has been
stated as £670,000 while that of 2018 has been £996,000. This value encompasses all the
non-current assets including the property their equipment as well as the manufacturing
inventory.
 According to the financial position the current assets a day in the financial year 2017 has
been stated as £347,000 while that of 2018 has been stated as £447,000. This amounts to
a total asset value forest limited of the years 2017 and 2018 combined to be £2,460,000.
 The share capital and retained earnings of “Roast Ltd.” for the years 2017 and 2018 state
the total equity of the company to be £1,639,000.
 According to the reports “Roast Ltd.” has long term borrowings from 2017 and 2018 to
the tune of £375,000 and the current liabilities amounting to £446,000 for both the years.
 In the “statement of profit or loss” it can be seen that for the year 2017 “Roast Ltd.” paid
out £30,000 as dividend (loss) which resulted in a closing balance of £579,000. Thus for
the year 2018 they have decided not to pay a dividend which has resulted in a closing
balance of £660,000.

“2.3 Statement of Cash Flow”

 According to the “statement of cash flows for the year ended 2018”, “Roast Ltd.” has
incurred losses in operations like increase in inventories, increase in “trade and other
receivables”, “interest paid”, and “income tax paid” which is resulted in a “net negative
cash flow” of “£24,000”.
 Moreover in its investing activities “Roast Ltd.” can be observed to have a “negative cash
flow” of “£358,000”. This clearly demonstrates that the managing body of the company
does not evaluate and assess carefully before making hefty investments.
 From all of the above it has been stated that the “net cash” and “cash equivalents” of
“Roast Ltd.” at the end of the financial year 2018 has been in a negative of £73,000.
“Operating Cash Cycle of Roast Ltd.”
In financial terms, an operating cycle is the average time taken between the acquisition of
inventory and the receiving of cash from the sale of that particular inventory. In business short
operating cycle implies that returns on investments are more generous and prompt. However a
longer operating cycle means that the return of investments takes a longer time and the inventory
that has been purchased exists for a longer period of time within the company, which has been
seen to hinder the cash flow. The former usually happens when the company is an economic
growth curve, while the latter seen during economic recessions [ CITATION Bil20 \l 1033 ].

The Operating Cash Cycle for “Roast Ltd.” has been calculated as:

Operating CashCycle=( Perio d of Accounts Receivable )+ ( Inventory Period )

The OCC for the year 2017: 1 year +30 days=395 days 
The OCC in the year 2018: 1 year +90 days=455 days 

“Dividend Policy”
A Dividend Policy is dependent on various factors like leverage, liquidity, profitability, size of
the company, and the associated market risks [ CITATION Bog15 \l 1033 ]. The dividend policy
of “Roast Ltd.” is based on distribution of profits among the different shareholders of the
company. It has been observed that the annual earnings of the company for the year 2017 have
been distributed among the shareholders according to the “dividend policy” of “Roast Ltd.”.
However, the shares of the annual earnings or profit for the year 2018 have not been distributed
among the shareholders leaving a dividend of zero for that year [ CITATION JAB91 \l 1033 ].
Moreover in the case of 2017 where “Roast Ltd.” won a legal battle against “Caffe Tostato”
wherein, the latter had to “pay £25,000” in “legal costs” and “£45,000 in damages”. This can be
considered as a type of earnings for the company and has been distributed among the
shareholders for the year 2017. Therefore, “Roast Ltd.” was right in not making “dividend
payments” in the year “2018”.
“Part 3: Investment Appraisal and Sources of Finance”

“3.1 Investment Appraisal”

 “Management Forecast”
Understanding and “forecasting” of the needs of the particular market segment is the basis for
effective management of the activities of distribution and manufacturing for a company like
"Roast Ltd.". Forecasting is essentially the process by which historical data of sales and revenue
generated are projected for future needs. Such kind of management forecasting helps to assess
the needs of the current market and their existing trends in order to make well informed
management decisions regarding strategy and operations of the company [ CITATION Ste97 \l
1033 ].

 Based on the data provided from the meeting between the “Loan Officer” at “Finance
Bank” and “Dan Shaw”, the “Chief Financial Officer” of "Roast Ltd.", It may be noted
that the total revenue generation from its Romania expansions for the year 2018 has been
£350,000, while that from the UK outlets has been to £2,184,000, which shows that its
expansion into Romania has not been successful enough.
 Added to this, the increasing cost of raw materials due to the demands of fair trade and
responsibly sourced coffee and associated ingredients, it can be seen that the cost of
production has been increasing for “Roast Ltd.”.
 Some of the cost-cutting measures incorporated by “Roast Ltd.” include the combination
of the role of “Marketing and Human Resource Director” with that of the CEO “Paola
King” with no additional salary. However this has the potential to greatly undermine her
role as the CEO due to the added responsibilities.
 The fact that in 2018 a particular business customer of “Roast Ltd.” suffered problems in
cash flow and delayed their payment period to 90 days is indicated above of the fact that
the market demand for “Roast Ltd.” might be declining in some customer segments. This
needs to be evaluated closely with the well conducted market analysis using and STP
model.
“Investment Appraisal Techniques”

 “Payback Period”
According to the given data, the break-even point for the Romania expansion of “Roast Ltd.” is
reached only during the 4th year, that is, 2021.

“Benefits” - The payback period method is used most because of its simplicity and ease off
calculation. In case of “rough analysis of a proposed business” the “payback period” can be
calculated easily without the use of complex spread sheets [ CITATION Bra20 \l 1033 ].

“Limitations” - The payback method often failed to consider the time value of money and thus
cash inflows and not adjusted accordingly. This method is limited in terms of calculating an
overall profitability for a business since it cannot calculate any inflows of cash exceeding the
“payback period” [ CITATION JBM19 \l 1033 ].

 “Accounting Rate of Return”

According to the given data using the “accounting rate of return” method “average annual profit
from investments” has been calculated to be 18%.

“Benefits” - The method of “Accounting Rate of Return” focuses on the “concept of net
earnings” after tax and “depreciation” and is important for “investment appraisals” [ CITATION
Mon20 \l 1033 ].

“Limitations” - Similar to the “payback period method”, the “accounting rate of return method”
does not take into account the “time value of money”. As a result two similar types of
investments food show uneven annual revenue streams [ CITATION Chr202 \l 1033 ].

 “Net Present Value”

According to the data of the “Net Present Value” method, it can be seen that the “net present
value” of “Roast Ltd.” is 110000. Given the “cost of capital” is 5%, the NPV shows a promising
value for “Roast Ltd.” and its future expansions into the extended European market.

“Benefits” - The “NPV method” is one of the most appropriate methods used industry-wide
because it does not entail assumptions of the reinvestment of revenue. It takes into consideration
all types of cash flow and risk factors as well as except conventional cash flow patterns
[ CITATION EFi20 \l 1033 ].

“Limitations” - This system has heavy Reliance on assumptions and estimations of metrics like
“investment costs”, “discount rate”, and “projected returns”; and as a result has significant room
for error within its calculations [ CITATION Wil203 \l 1033 ].

“3.2 Sources of Finance”

“Equity Crowd funding” can be used and the benefits of it are that it increases access to
investors, is affordable to a large extent, increases efficiency of business expansion and
maintains control over company valuation. However, the major limitation is that most ECF
platforms have a limitation of maximum funds raised.

Peer to peer lending can also be used such that the interest rates and repayment periods are
highly flexible and processing times are one of the fastest in terms of availing loans. However, in
most P2P lending platforms an application fee is mandatory and there are strict systems of credit
and other internal checks.

The most preferred course of action would be to enlist on more than one ECF platforms to
generate the required £400,000 for expansion into Italy.
“References”
Baginski, S. P. & Hassell, J. M., 1997. Determinants of Management Forecast Precision. The
Accounting Review, 72(2), pp. 303-312.

Baksaas, K. M., 2019. Proposal for improved financial statements under IFRS. Cogent Business
& Management , 5(1).

Bragg, S., 2020. Advantages of the payback period. [Online]

Available at: https://www.accountingtools.com/articles/advantages-of-the-payback-period.html
[Accessed 14 August 2020].

Brickley, J. & McConnell, J., 1991. Dividend Policy. In: M. M. N. P. Eatwell J., ed. The World
of Economics. London: Palgrave Macmillan, pp. 168-175.

Cebr, 2018. The UK coffee market and its impact on the economy: A report for the British Coffee
Association. [Online]
Available at: https://www.britishcoffeeassociation.org/assets/files/uploads/BCA%20CEBR%20-
%20The%20economic%20value%20of%20coffee%20in%20the%20UK
%2020%20April_FINAL.pdf
[Accessed 14 August 2020].

E Finance Management, 2020. Advantages and Disadvantages of NPV. [Online]

Available at: https://efinancemanagement.com/investment-decisions/advantages-and-
disadvantages-of-npv
[Accessed 14 August 2020].

Esquires Coffee, 2019. Trends of the UK Coffee Shop Industry. [Online]

Available at: https://esquirescoffee.co.uk/news/trends-uk-coffee-shop-industry/
[Accessed 14 August 2020].

IBIS World, 2019. Cafes & Coffee Shops in the UK - Market Research Report. [Online]
Available at: https://www.ibisworld.com/united-kingdom/market-research-reports/cafes-coffee-
shops-industry/
[Accessed 14 August 2020].

Kaźmierska-Jóźwiak, B., 2015. Determinants of Dividend Policy: Evidence from Polish Listed
Companies. Procedia Economics and Finance, Volume 23, pp. 473-477.

Kenton, W., 2020. Net Present Value (NPV). [Online]

Available at: https://www.investopedia.com/terms/n/npv.asp
[Accessed 14 August 2020].

Krylov, S., 2018. Target financial forecasting as an instrument to improve company financial
health. Cogent Business & Management, 5(1).

Lefley, F., 1996. The payback method of investment appraisal: A review and synthesis.
International Journal of Production Economics, 44(3), pp. 207-224.

Maverick, J., 2019. Limitations of Using a Payback Period for Analysis. [Online]
Available at: https://www.investopedia.com/ask/answers/062915/what-are-some-limitations-and-
drawbacks-using-payback-period-analysis.asp
[Accessed 14 August 2020].

Mintel, 2019. UK Coffee Shops Market Report. [Online]

Available at: https://store.mintel.com/uk-coffee-shops-market-report
[Accessed 14 August 2020].

Money Matters, 2020. Accounting Rate of Return (ARR) Method | Advantages | Disadvantages.
[Online]
Available at: https://accountlearning.com/accounting-rate-of-return-method-advantages-
disadvantages/#:~:text=Advantages%20of%20Accounting%20Rate%20of,economic%20life
%20of%20the%20project.
[Accessed 14 August 2020].

Murphy, C. B., 2020. Accounting Rate of Return – ARR Definition. [Online]

Available at: https://www.investopedia.com/terms/a/arr.asp
[Accessed 14 August 2020].
Murphy, C. B., 2020. Operating Cost. [Online]
Available at: https://www.investopedia.com/terms/o/operating-cost.asp
[Accessed 14 August 2020].

Nordmeyer, B., 2020. The Difference Between Operating & Cash Conversion Cycles. [Online]
Available at: https://smallbusiness.chron.com/difference-between-operating-cash-conversion-
cycles-24738.html
[Accessed 14 August 2020].

Pwc, 2020. More for less: Five steps to strategic cost reduction. [Online]
Available at: https://www.pwc.com/gx/en/insurance/publications/firing-on-all-cylinders-five-
steps-to-strategic-cost-reduction.pdf
[Accessed 14 August 2020].

Statista, 2016. Leading coffee shop chains United Kingdom (UK) 2016, ranked by store number.
[Online]
Available at: https://www.statista.com/statistics/297863/leading-coffee-shop-chains-in-the-
united-kingdom-uk-store-number/
[Accessed 14 August 2020].